More rules needed to halt new financial crisis: ex-Bank of Canada head

Ottawa and Washington need to regulate securities firms like they do banks to prevent another meltdown like the asset-backed commercial paper collapse, the former governor of the Bank of Canada says.

David Dodge said it was this lack of strict rules governing investment houses and other financial institutions that worsened the current financial debacle in North America.

Former Bank of Canada governor David Dodge, seen at right in 2007, says central banks saw the financial crisis coming years ago. (Associated Press)

"We have moved so much into the market in rather complex ways that it is hard to see how we can avoid systemic crises without bringing all of the big-system financial players into some sort of collective regulatory oversight," Dodge said in Friday's edition of the Globe and Mail newspaper.

"To pretend that these [players] can operate according to private-sector principles is just lunacy."

Dodge, Canada's central banker from 2001 until retiring earlier this year, recently joined the Ottawa office of the Toronto law firm Bennett Jones.

The recent collapse of real estate prices in Canada and the United States effectively killed the mortgage-backed commercial paper market and left financial firms with huge amounts of debt, putting at risk their ability to stay afloat.

As a result, numerous banks were forced to write down large amounts of loans and some investment houses even teetered on the brink of bankruptcy.

'We let the children out into the schoolyard and they acted badly.'—Don Drummond, TD Bank senior economist

So far this year, JP Morgan Chase & Co. took over Bear Stearns Cos. in a fire sale as the latter Wall Street firm's financial woes threatened its viability and threw a pall over the entire economy.

More recently, Lehman Brothers Holdings Inc. announced huge losses and a radical restructuring program to deal with its debt.

Central banks in various countries saw the problem growing years ago as firms developed new financial instruments that gave firms access to capital resources, but with an associated higher level of risk, Dodge said.

"What we had was a financial system where leverage increased quite substantially while credit controls declined. Financial instruments were introduced and nobody had any idea about the risks," he noted.

National bank governors questioned

Wall Street and Bay Street, however, did nothing to reduce the amount of borrowing relative to the financial assets on company balance sheets.

As a result, once real estate prices started sliding, the value of the assets backstopping this corporate borrowing fell, forcing brokerage houses and banks to write off huge amounts of now-worthless financial paper.

Hiking capital requirements, so that investment houses would be forced to hold more actual actual cash to support their paper assets, would be one answer, said Don Drummond, senior economist with TD Bank.

Drummond, a former senior official at the Department of Finance in Ottawa, was not surprised with the calls for increased financial services regulation, analogizing: "We let the children out into the schoolyard and they acted badly," he said.

Drummond questioned, however, why governors of the various national banks were not saying more about the crisis at an earlier time.

"I didn't see them expressing these thoughts back then [in 1993]. I don't remember it," he said.

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